Written By: John Abbot
Economists make models based on extensive research and the assumption that humans are predictable and rational. The problem is that humans are not rational nor predictable. Humans are very emotional and near sighted, leading to irrational and sporadic choices. This creates a contrast between economists and humans. Although economists may make policies that are perfect for economists, they are not perfect for everyday people in the market. To reduce this gap behavioral economists study human behavior in markets to apply to new policies. One theory developed by behavioral economists is nudge theory: a way to manipulate people’s choices to lead them to make a specific choice through small suggestions and positive reinforcements (nudges). Emphasis on small suggestions. Putting fruit at eye level and treats in harder to find areas helps nudge a more healthy diet. However, banning all junk food is too extreme to be a nudge. Nudge theory has become very popular in public policy, as well as advertising in general. Understanding nudge theory helps one apply it for benefits, as well as identify it when getting manipulated into a bad decision.
A very popular application of nudge theory is setting defaults. Most people end up staying with the default options, especially in saving decisions, organ donation and privacy choices. Public policy makers use this to their advantage when dealing with workers and their 401k’s. To help nudge workers into saving more money for retirement, workers are by default opted into a 401k savings plan with the ability to opt-out (Witynski). This nudge has been seen as very successful by policy makers and has even gotten updates such as in the bipartisan bill known as “Secure 2.0” in which American businesses starting new plans will automatically enroll workers in a 401k and set aside at least 3% but no more than 10% of their paycheck for the first year (Bernard).
Another application of nudge theory relies on loss aversion. Loss aversion is the idea that people are more averse to losses than they are eager to make gains. Imagine someone flipped a coin, and if it landed on heads he would give you 100 dollars, but if it landed on tails you had to give him 50 dollars. The math says that you should take this bet, yet many fear the risk of losing 50 dollars more than the reward of winning 100 dollars. Grocery stores have used this behavior to help nudge customers into being more renewable and cost efficient. Grocery stores in the Washington, D.C area tried to reduce the use of plastic bags by offering a 5 cent bonus if customers brought reusable bags. This policy was not effective, so they shifted it to a 5 cent tax on customers for using plastic bags. It was then that customers brought their reusable bags and the amount of plastic bags reduced (Hill, A., & Clifford, J.).
It is important to note that nudge theory is not always used for consumers’ benefits. Businesses take advantage of nudges to turn more of a profit. A very common nudge used by businesses is exploiting the availability heuristic. This refers to the idea that people often rely on easily recalled information, rather than actual data, when evaluating the likelihood of a particular outcome (Witynski). Many businesses will place more expensive goods at eye level to customers so they are more available. Stores place goods at checkout to gauge the attention of customers before they leave. More subtle is fast food restaurants asking customers if they want a large fry as opposed to just asking if they want fries. Credit cards also use extensive advertisement and make signing up for a card super easy to nudge more customers their way. Just to be hit by numerous different fees (Amir, O., & Lobel, O.).
One factor that continues to influence nudge theory is software and the overall increase in information being available to people everyday (Amir, O., & Lobel, O). It will be a lot harder to swing a customer one way when they have access to all prices and fees. As well as all the behavioral factors that can be influenced while shopping in stores like smell, placement, and workers. Shopping online takes away the availability heuristics like placing higher priced goods at eye level and having goods placed at checkout. This new technology also provides the producers with ways to adapt the nudge theory. Amazon uses the technology to suggest similar items as well as items that were bought complementary to past purchases.
In all, nudge theory helps both increase and decrease the gap between rationality and irrationality in markets. Nudge theory is a lens which proves small changes can lead to huge changes in the economic environment. Setting defaults, loss aversion, availability heuristic, and technology are all strong applications of nudge theory that policy makers as well as businesses use to influence your consumption. Nudge theory is everywhere and has proven influential in creating a positive environment. Being able to identify nudge theory in everyday life is a small step everyone can make to develop their environment in a positive way.
References
Amir, O., & Lobel, O. (2008). Stumble, Predict, Nudge: How Behavioral Economics Informs Laws and Policy. Columbia Law Review, 108(8), 2098-2137.
http://www.jstor.org/stable/40041817
Bernard, T.S (2022, December 20). New spending bill makes it easier for Americans saving for retirement. The New York Times
https://www.nytimes.com/2022/12/20/your-money/spending-bill-401k-retirement-savings.html
Hill, A., & Clifford, J. (2016, March 12). Behavioral Economics: Crash Course Economics #27. Youtube. https://www.youtube.com/watch?v=dqxQ3E1bubI
Nudges. (n.d). Economics Help. https://www.economicshelp.org/blog/glossary/nudges/
Witynski, M. (n.d). Behavioral Economics, explained. University of Chicago News. https://news.uchigago.edu/explainer/what-is-behavioral-economics